China Connection: Partners needed in giant market

In the last of a six-week series on export opportunities in China, Nick Stride charts the course for New Zealand's dairy export industry

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A young girls on her father's shoulders in a market in Xian, China. Photo / Mark Mitchell

"This will be a long road, and it won't be a straight one."

Fonterra's Head of Greater China, Kelvin Wickham, knows very well the dangers New Zealand companies face in China - a country that will soon surpass the United States as the world's largest economy.

China - the biggest market for New Zealand's biggest company - is growing so fast that it can't hope to feed its own population for many years. It will have to rely on imports, and New Zealand is already its largest supplier of dairy products.

So there's a huge opportunity for the New Zealand companies who process our farmers' raw milk. But there are also huge risks.

An agri-business delegation headed by the Bank of New Zealand recently attended the China Dairy Expo and Summit in Xian and visited Beijing and Shanghai, talking both to Kiwi entrepreneurs doing business in China and to locally-based Chinese enterprises.

The growth in demand for dairy products in China is so large that New Zealand - even though we're the world's biggest dairy exporter - can't hope to supply even a modest part of it. In the last six months alone China imported almost two million tonnes (MT) of dairy products. New Zealand's entire annual production is 19 MT.

Rabobank, one of the world's largest agricultural financial institutions, estimates the gap between the milk China produces internally and what it consumes is 10 billion litres, and widening. By contrast Fonterra collected 16.7 billion litres of New Zealand milk in the 2013 season.

Fonterra's Wickham says Fonterra expects to double its trade with China, by volume and by value, by 2020.

Even so, he says, New Zealand supply alone will not be able to meet China's ongoing demand. "Most of it will have to be from local supply."

That's why Fonterra is building dairy farms on the ground in China, like the recently-announced $342m joint venture with American pharmaceuticals and health care giant, Abbott. That allows Fonterra to accelerate expansion in China and bring closer its goal of producing 1 billion litres of milk a year there.

The partners said they would develop a dairy farm hub in China comprising up to five dairy farms and more than 16,000 cows, producing up to 160 million litres of milk a year. Fonterra chief financial officer Lukas Paravicini said at the time Abbott was a Fortune 500 company and a world leader in the infant formula market with a significant presence in China. The deal would combines Fonterra's farming experience in China with Abbott's expertise on the nutritionals side.

"It allows us to speed up our strategy on the farming side in China," he said.

Coinciding with Fonterra's announcement was a report from agricultural lending specialist Rabobank, which said major players in the global scene needed to buy others or enter more joint ventures to maintain the strong growth they had enjoyed in recent years.

Wickham says Fonterra is taking a 'partnership' approach, taking into account the big differences between the two countries in how you get from "cow to consumer."

"China's a feedlot (crops) market, unlike New Zealand's pasture-based (grass) system. But there have been huge changes in the last five years. There is now large-scale corporate dairy farming, and an increasing amount of their milk now comes from herds of 500-plus cows.

"Fonterra's view is that in China a herd size of around 3000 milking cows provides an economic farm model. That's particularly so if you group them into a hub of farms producing, say, 150 to 200 million litres of milk a year."

Wickham agrees with the often-expressed view that New Zealand needs to move on from its reliance on exporting commodity milk products but says the difference between the two markets must be understood.

"The big difference between us and China is that they are primarily focused on their domestic markets. For us, our local New Zealand market is just a small part of what we do.

"In the China market, exported Whole Milk Powder (WMP) is our main product. But within China, the first use of the milk tends to be for fresh dairy products and dairy beverages."

There lies the opportunity. According to a recent Treasury paper, "as incomes grow Chinese consumers will be willing to pay higher prices to secure quality food products as a lot of people do not trust the quality of locally-produced product."

Wickham says Chinese consumers are also developing a fusion of Western and Eastern tastes.

"It's an ever-changing landscape, and there is constant innovation. It's also a melting pot of supply origin. In Shanghai supermarkets you can buy dairy products from New Zealand, Australia, Europe or others parts of Asia."

None of this is to say New Zealand's commodity dairy products are about to lose their relevance to China.

The UN Food and Agricultural Organisation predicts imports into China of Whole Milk Powder (WMP), Skimmed Milk Powder (SMP), butter and cheese will increase by 14 per cent, 47 per cent, 13 per cent and 135 per cent respectively over the next decade.

Wickham says that, in the commodity space, New Zealand's contribution will be in supplementing the gap between Chinese demand and supply. This gap will keep expanding over the next 5 to 10 years. So those gigantic milk dryers at Darfield and Edendale won't fall silent any time soon.

But if the longer-term opportunity is in partnering with Chinese producers, is there a danger New Zealand will end up simply selling away the innovation and the IP (intellectual property) that our biggest industry has built up?

Says Wickham: "We're here for the long term and we take a long term view. Fonterra has an integrated play, from farm to consumers. I would argue that the value of any IP is in the ecosystem of an integrated, high quality milk supply chain.

"The software is about having the people capability to care for our animals and feed them right, wrapped in a quality control system that ensures milk of the highest quality. This is something that can't easily be copied," Wickham says.

"Of course we need to be sure we extract fair value for the value we've created. And the Chinese industry understands that. They understand that we can deliver the high-quality milk outcome that they're looking for."